Who wants to own a startup?

What you can now stand to get in return for crowdfunding a startup

Being someone with a slightly more than a passing interest in the world of crowdfunding, I popped along to NESTA last week for the launch of ‘The Venture Crowd’, a new research report into equity crowdfunding. Do have a look, it’s worth a browse – and mercifully, compared to most social research it’s pretty concise and to-the-point. Which is nice.

I’m going to blog next week on what NESTA and other similar organisations could do to boost demand for non-equity crowdfunding (in short: a lot more), but for now here’s some thoughts on the new kid on the block:-

What it is

If crowdfunding was the next big thing in 2010-11 (with NESTA estimating that $1.5bn was raised for crowdfunding projects in 2011 alone), then equity crowdfunding is making a strong case to follow suit for 2012-13. The concept is pretty simple – take the concept of getting lots of people to give a little bit of money to help make your project happen, and instead of offering them kooky rewards (like your name weaved into the side of a bus) you offer them a stake in your company. If your business idea takes off, your backers- from £10 upwards – get a share of the return. The vast majority of equity offered in this space so far has been non-voting, so if you’re a crowd-investor you’d have to sit tight and cross your fingers to hope your company does well.

To date, equity crowdfunding platforms have been thin on the ground, given the complexity of navigating financial regulation. For once, the UK is out in front here, with Crowdcube launching just over a year ago (Check out their excellent infographic on their first year’s work, where they raised over £2.8m raised for 15 fully funded pitches), but with the passing of the JOBS Act in the US – which among other things lifts the majority of regulatory burden for companies seeking to raise money from a large number of small investments – expect to see an explosion of new platforms any minute. The UK market is starting to form too, with Seedrs, winner of the recent London Web Summit launched only last week, trumpeting the fact that it is fully authorized by the UK authorities.

Who it’s for
It’s way too early to tell what sort of businesses might stand the best chance of success in trying to crowdsource startup capital – judging by Crowdcube, most seem to be consumer-facing brands seeking to sell a product or service to the general public, starting with a new bubble bath manufacturer. Soon-to-launch CrowdMission is aiming to try something a bit different, with a focus on social and sustainable businesses, rather than naked profiteering. This is an interesting proposition: while there’s no question that projects with a social purpose dominate the non-equity stakes (so with the right pitches the platform should be able to get ‘normal’ people excited about investing) – and I reckon non-equity finance for social businesses could still turn out to be a game-changing proposition – will micro-investors really be motivated by returns that are surely smaller than for-profit competitors? And if so, is it truly a more attractive proposition to offer non-voting equity with a tiny return, compared to a really exciting non-financial reward?

Which brings me on to (imho) the great unanswered question – who do these new platforms want as their ‘crowd’? Is this a play for genuinely new micro-investors, or simply a way of getting existing angel investor communities to put their cash elsewhere (so, something like FundingCircle)?

 This is a question that occupied much of our time when we ran WeDidThis, and was where NESTA’s session last Tuesday got interesting – when pushed on the question, answers ranged from angel investor Ami Shpiro’s view that this would complement offers for existing big investors (who do need “somewhere to go“, and a crowdfunding platform would be as good as anywhere) to CrowdMission founder Karen Darby’s more emotive “people like my Mum“. And lots inbetween.

 This is an important question, because it helps us start to understand how big the market could be for this form of funding. It may be that an initial base of bigger, traditional investors create a critical mass that helps popularise this for new micro-investors. But for now, I’m not quite sure – for instance, although Crowdcube’s statistics suggest that they are a crowd of small investors, I’m not sure that’s the full story. Their average donation size is up at around £1.9k, which seems quite a lot for ‘cold’ investors. As a comparison, for my site WeDidThis our equivalent was about £30, and although I’d expect there to be a fair disparity between the two sites, to know that this is really pulling in the masses, it’d be great to see this number come down a bit over time.

 

A typical CrowdCube pitch

Why I’m excited 

In theory, equity crowdfunding is absolutely brilliant:

  • It makes the process of seeking finance totally open (and, with luck, fun) and makes startup executives think about building broad word of mouth support from the word go. Which can be a really powerful tool in making new companies grow faster.
  • It enables everyone to participate and benefit from the growth of UK startups. Getting involved with making new companies grow is really exciting, but so far is the preserve only of a small number of dragons. Equity crowdfunding can change this, creating a whole new class of micro-investors.
  • For startups, the option of going to the crowd for capital could be a useful (if labour-intensive) way to bridge the gap between very early-stage loans and grants, and going for bigger investment (and ultimately listed company status).

Why I’m wary
However, equity crowdfunding is a very different proposition to backing a Kickstarter project and I’m really not sure we’ve fully bottomed this out. Here are a few of the concerns lurking in the back of my mind:-

  • How to balance encouraging new investors and warning them about the risks – As this blog sets out much more eloquently than I could, we are talking about very high-risk equity here. That’s not to say that buying it isn’t fun. Just that you shouldn’t bank on getting your money back. (And to be fair to CrowdCube and Seedrs, they are very clear about this). The JOBS Act takes an interesting approach to this, limiting the amount that non-accredited investors can invest in equity crowdfunding – subject to much lighter regulation than traditional investment – to 2% of their income, up to $10,000.
  • But go too far on investor protection and you risk putting off casual investors (who are surely the target market for this). For example, while I’m really excited about what Seedrs will do and think the team look great, I found registering to become an investor with them a somewhat burdensome process – I went through two long questionnaires, downloaded a 26-page contract had to agree to the statement below, and then had to send in copies of my passport and driving licence:-

Although you will be able to invest a minimum of £10 in any given business through the Seedrs platform, we strongly advise you to build a highly diversified portfolio. You should therefore plan to invest no less than £1,000 in aggregate if you are going to invest through the platform at all.”

Is amassing a £1,000 highly diversified portfolio really ‘crowdfunding’ as we’ve come to understand it? I’m not so sure….

  • Governance/ vetting risk – It’s taken 2 years for the first case of a high-profile crowdfunding fraud, which is not bad going, all told. Given the massive volume of projects going through Kickstarter, that’s not a bad rate, and when you’re talking about a site that mainly takes small donations (nb not investments), most people seem to be happy with the general success of Kickstarter’s self-policing policy. However, turn small donations into slightly larger investments and things change. Although Darren Westlake from CrowdCube has been pretty candid about rejecting lots of pitches coming his way, I do think we need to keep talking about how platforms can help their users get to know the companies pitching for their cash.
  • Getting the offer right – As Jeff Lynn, Seedrs’ founder, said at the NESTA session, this sort of funding offers financial and social return wrapped together, so investors are likely to tolerate lower financial return. All well and good. However, although I can well understand why startups would be reluctant to gain a crowd of voting shareholders (at such a low entry point), it’d be great to see companies start to get a bit more innovative about how they enable their crowd-investors involved in growth of the company they are investing in.

In conclusion, there is a hell of a lot to be excited about here – but to make this a truly inclusive movement, I think platforms will need to find innovative ways of helping their users discover and get to know the companies pitching for support, cultivating a user offer that makes very small equity investing a valuable and fun experiece for the micro-investor, while being super-clear on the risks.

But if we can get all that right, this could make capitalism very interesting indeed. And it could help quite a few smashing startups get off the ground.

Check back next week for more on how we can make everyone into crowdfunders, including reaction to Kickstarter’s announcement that they’re coming to the UK…..

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7 Comments

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7 responses to “Who wants to own a startup?

  1. I think an equity-crowdfunded company can do a lot to engage with its long tail of investors; but would hesitate to be prescriptive about how to do that. I think that for any consumer facing business it would be a mistake not to engage them. Hundreds of instant evangelists, spreading all your news through disparate social networks (on and offline variants)? Very powerful.

  2. A very interesting and useful post Ed. There are a lot of misconceptions about crowdfunding as well as the risk/returns on financial investment. Entrepreneurs and investors need to be aware of the concerns and risks as well as the potential of this model.

    Here is a useful post from Rebecca Mills from Semple Fraser which outlines some of the issues for businesses http://www.semplefraser.co.uk/a/CorpUpdateApr12

  3. Interesting and insightful, but undermined by the puzzling and inflammatory comment about “sustainable businesses, rather than naked profiteering”.
    In order to be sustainable, a business must generate surpluses (ie profit), surely? So why make it sound as thought this is a bad thing?
    #JustSaying

    • Ed Whiting

      Amanda, thanks- you’re absolutely right. I agree that the distinction is false, and I was wrong to imply that profit/ sustainability are entirely distinct concepts (I think blog etiquette dictates that I shouldn’t go back and edit this out though!). My point was much less controversial, I think- that the returns we are talking about here are complex, and it will be interesting how the mix of pitches majoring on financial return compared with those offering something more ‘blended’ (ie with a strong social aspect) changes over time. Thanks for catching this though! Will be much less careless in future posts…. Ed

  4. Pingback: Who wants to own a start-up? | Nesta Innovation in Giving

  5. Great post Ed, but I’m not sure if I’m reading the abridged version? Just to be clear, CrowdMission is about helping investors and entrepreneurs make money AND make a difference. Profit and social return are not mutually exclusive and I’m living proof! My company, SimplySwitch created 100 jobs in one of the UK’s most deprived areas (mainly for unemployed youths), we helped consumers to save over £20 million on their energy bills, educated everyone we spoke to on the benefits of renewable energy, (and we planted a tree for those that switched to a greener tariff), we raised over half a million pounds for various charities and we produced a whopping 22 x multiple for the investors within four years (equating to 164% IRR). In my opinion, with the right proposition both the social, environmental and financial rewards can be eye-watering. And this is exactly the type of business that CrowdMission intends to support.

    • Ed Whiting

      karen, the link to the full article’s here– not sure which version you were reading (my first draft was very long indeed though so if it feels like what you read has been cut down a bit, that’s why!).

      I really liked what you said at the NESTA launch, and the proposition for CrowdMission is fantastic. My only query was how potential investors will seek to balance up all of the elements in their return when assessing whether to invest- what I was trying to imply was that when the individual investment size is very small (as you would expect for a proper social ‘crowd’), the absolute financial value of the return is likely pale into insignificance when set against the social value/ return/ impact created for the investor. Which is not to repudiate at all what CrowdMission is doing- but just to say that my view is that for a fantastic social proposition, financial return may be relatively low on the list of motivating factors for ‘ordinary’ investors. Although the same of course may not be true for ‘bigger’ investors, where a return becomes much more important (as it is a driver of the investing fund’s sustainability).

      Hope that helps clear things up! Really looking forward to seeing CrowdMission launch- and good luck.
      Ed

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